Perpetual Futures Dominate Bitcoin and Ether Markets, Affecting Price Discovery

The process of setting crypto prices is often misunderstood, with many believing it occurs through spot trading, where buyers and sellers meet on an exchange. However, the reality is that perpetual futures, also known as perps, play a significant role in determining prices for bitcoin, ether, and other cryptocurrencies. These leverage-friendly contracts never expire and account for approximately 93% of all crypto futures volume, with daily perp volume often surpassing the spot market. A traditional futures contract has a settlement date, which forces its price to meet the spot price of the underlying asset. In contrast, perps can be held indefinitely by paying a funding rate, which varies daily. Research has shown that derivatives, particularly perpetual swaps on unregulated venues, are the primary drivers of bitcoin price discovery, with regulated futures and US spot exchanges reacting to these moves. The evidence suggests that the derivatives market is where prices are made, with spot markets following. This phenomenon was recently demonstrated in the SpaceX IPO, where perpetual futures contracts accurately predicted the stock's opening price, outperforming traditional Wall Street predictions. The funding rate, which is the cost of holding a perp position, serves as a tether to the underlying price and provides a live readout of market sentiment. Traders closely watch the funding rate, as it can indicate the direction of the market. The SpaceX example highlights the dominance of perps in price discovery, even in traditional markets. The company's IPO was priced at $135 per share, but perpetual futures contracts were trading at around $170 per share before the listing, accurately predicting the stock's first-day performance. This gap between the perp price and the IPO price presented a trading opportunity, as the contracts would automatically switch to the stock's price after listing. The subsequent price movement of SpaceX's stock, which has fallen over 40% from its peak, was influenced by factors that perps could not have priced, such as supply. The experience demonstrates that perps are excellent at pricing demand but blind to supply, a crucial consideration in understanding market dynamics.